Daoming Optics&ChemicalLtd (SZSE:002632) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Daoming Optics&Chemical Co.,Ltd (SZSE:002632) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Daoming Optics&ChemicalLtd

What Is Daoming Optics&ChemicalLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Daoming Optics&ChemicalLtd had CN¥375.0m of debt, an increase on CN¥830.4k, over one year. But it also has CN¥949.0m in cash to offset that, meaning it has CN¥574.0m net cash.

How Strong Is Daoming Optics&ChemicalLtd's Balance Sheet?

According to the last reported balance sheet, Daoming Optics&ChemicalLtd had liabilities of CN¥763.5m due within 12 months, and liabilities of CN¥31.2m due beyond 12 months. On the other hand, it had cash of CN¥949.0m and CN¥377.5m worth of receivables due within a year. So it can boast CN¥531.7m more liquid assets than total liabilities.

This surplus suggests that Daoming Optics&ChemicalLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Daoming Optics&ChemicalLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Daoming Optics&ChemicalLtd has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Daoming Optics&ChemicalLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Daoming Optics&ChemicalLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Daoming Optics&ChemicalLtd recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Daoming Optics&ChemicalLtd has net cash of CN¥574.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 23% year-on-year EBIT growth. So we don't think Daoming Optics&ChemicalLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Daoming Optics&ChemicalLtd you should be aware of, and 1 of them is concerning.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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